Analysts say not all these currencies will last and very few people actually use them at the moment. But in the long run, virtual currencies could disrupt the market for traditional finance companies like banks, or remittance companies like Western Union, which handle money transfers. For one, the Royal Canadian Mint demonstrated MintChip, a digital payment platform, on Monday, the first country entering the game.
A Rush For Virtual Gold
Few of the many virtual currencies will last, says Nick Holland, senior analyst at the research firm Javelin Strategy & Research. In the latest forecast, his group estimated the virtual currency market would have doubled to more than $10 billion by the end of last year. He says they haven't seen signs that suggest otherwise.
"It's something of a gold rush right now; there are a lot of them out there," Holland says. "A lot of them will not make it at all; a lot of them are just science projects that people are playing around with."
However, if the currencies themselves don't stay, the idea driving them will, according to Holland and Joshua Gans, professor of strategic management at the University of Toronto.
"It's surprisingly difficult to transfer money between banks, and the question is, 'Why should that be?' " Gans says. "Some of these [virtual currencies] are trying to see if they can eliminate that, but of course the banks will come in and say, 'Well, we were charging people for those things in the past; we won't anymore.' "
But just to take Bitcoin as an example, the exchange rate is far from stable. Also, Holland cautions that just as voice-over-IP technology like Skype took years to become mainstream, the same will be true for virtual currencies, even ones that have been making headlines lately.
"Look at Bitcoin as a canary in the mine," Holland says. "The actual usage among the population at large is a drop in the ocean."
But, some significant players have noticed that drop.
On Monday, the Royal Canadian Mint demonstrated MintChip, a digital money transfer platform, at the National Retail Federation's convention in New York City. Although it is not a virtual currency, Holland and others say this shows that governments are starting to pay attention; a sign that virtual currencies are more than just a fad. Bank of America Merrill Lynch recently released its first assessment of Bitcoin, saying the cryptocurrency can become "a major means of payment for e-commerce" that "may emerge as a serious competitor to traditional money transfer problems."
Virtual currencies are getting noticed because they've made it easy for developers who want to add payment features to their apps or sites, says Vili Lehdonvirta, a research fellow who studies virtual currencies and economies at the University of Oxford's Internet Institute. He points out that unlike banks, Bitcoin has an open application programming interface (commonly known as API), which is a way for two applications to talk to each other, that anyone can use.
"That's facilitating open innovation, and I think that's one of the key takeaways that traditional financial industry players are taking from cryptocurrencies," Lehdonvirta says.
On the other hand, he cautions that because few people actually use Bitcoin and other virtual currencies, all the buying and holding is pushing the exchange value up without contributing anything to the economy. And if it goes wrong, it could end up like the dot-com bubble of the '90s when "people were buying stock like crazy," Lehdonvirta says.
"I've had some people say that, 'Oh, maybe I should put my pension savings in Bitcoin,' which I think is a really bad idea," he says.
Virtual currency is just the start, says Chris Larsen, co-founder and CEO of Ripple, an Internet payment protocol company. Ripple has a virtual currency like Bitcoin, but uses it as a kind of common denominator to let people make transactions in any currency they like.
Larsen compares it to the early days of email, when AOL or Prodigy users could not send messages to people on a different platform. He hopes Ripple can be the common platform that lets people send money online regardless of currency.
"A virtual currency is just the tip of the iceberg," Larsen says. "We think there's going to be an explosion in the numbers of things of value that people will use, but the more important need is actually a protocol that seamlessly exchanges all those things of value, whether they be Bitcoin, or dollars, or yen, or airline miles."